Question

An old two-flat can be purchased for $200,000 cash. The two units can bring in a total of $2,500 per month (allowing for normal vacancies). The total operating expenses for property taxes, repairs, gardening, and so forth are estimated to be $200 per month. For tax purposes, straight-line depreciation over a 20-year remaining life with to a zero salvage value will be used.

Of the total $200,000 cost of the property, $50,000 is the value of the land. Assume a 38% marginal income tax bracket (combined state and federal taxes) applies throughout the 20 years. This tax rate applies to ordinary income and capital gains/losses.

Since there is no growth expected in rents or expenses, depreciation is straight-line, and the tax rate doesn’t change, the ATCF’s for each year, 1 to 20, will be the same.

What after-tax IRR would you expect assuming that the property is held for twenty years and then sold for $50,000?

What after-tax IRR would you expect assuming that the property is held for twenty years and then sold for $150,000?

Answer 1

Initial investment	-200000
Cash flow per month	2500
Less : Operating expense	-200
Monthly net cash flow	2300
Annual operating cash flow (12*2300)	27,600
Less : Depreciation (200000/20)	10,000
Earning before tax	17,600
Tax @38%	10,912
Net income	6,688
Free cash flow = Net income + Depreciation	16,688